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Hilltop Holdings Inc. (NYSE:HTH)

Q2 2014 Earnings Conference Call

July 31, 2014 09:00 AM ET

Executives

Isabell Novakov - IR

Jeremy Ford - President and CEO

Darren Parmenter - Principal Financial Officer

Alan White - CEO, PlainsCapital Corporation

John Martin - CFO

Analysts

Michael Rose - Raymond James

Brett Rabatin - Sterne, Agee

Matt Olney - Stephens

Brady Gailey - KBW

Operator

Good morning, and welcome to the Hilltop Holdings Second Quarter 2014 Earnings Presentation and Webcast. All participants will be in listen-only mode. (Operator Instructions). After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

I would now like to turn the conference over to Isabell Novakov. Please go ahead, ma’am.

Isabell Novakov

Good morning. Joining me on the call this morning are Jeremy Ford, President and CEO of Hilltop Holdings; Alan White, CEO of PlainsCapital Corporation; Darren Parmenter, Principal Financial Officer, Hilltop Holdings; and John Martin, CFO.

Before we get started, please note that today’s presentation may contain forward-looking statements. These statements are based on management’s current expectations concerning future events that by their nature are subject to risks and uncertainties. Our actual results, capital and financial condition may differ materially from these statements due to a variety of factors including the precautionary statements referenced in our discussion today and those included in our most recent annual report and quarterly report filed with the SEC.

And now I would like to hand the presentation over to Jeremy Ford.

Jeremy Ford

Thank you, Isabell and good morning. For the second quarter of 2014, income to common stockholders was $27.1 million or $0.30 earnings per diluted share. Our return on average equity was 8% in the quarter compared to 7.3% in Q2 2013. Our return on average assets was 1.24%.

PlainsCapital Corp subsidiaries reported pretax income of $51 million while National Lloyds had a pretax loss of $5.5 million for the quarter. Total assets increased to $9.4 billion compared to $8.9 billion at December 31. Total stockholder's equity increased by $85 million from December 31 to $1.4 billion. Hiltop remains well capitalized for 13.5% Tier 1 leverage ratio and 18.8% total risk based capital ratio and Hiltop retains a $158 million of freely usable cash as well as excess capital and added subsidiaries.

The SWS acquisition is still pending and we continue to work on obtaining SWS shareholder and regulatory approval by year end moving forward. Income to common for the quarter was $27.1 million, compared to $24 million in the prior quarter and $21 million in the prior year. Our book value per share is $14.22 versus $13.76 in the prior quarter $12.59 in the prior year.

Our net interest margin continues to expand and was 5.18% for the quarter compared to 4.6% for the prior quarter and 4.33% for the prior year. Our gross loans are up 4.6 billion at the end of this quarter, compared to $3.3 billion in the prior year and our deposits at the end of the quarter were $6.2 billion, down from $6.7 billion in the prior quarter though up from $4.5 billion in the prior year and our NPAs to total assets continue to improve to 30 basis points.

I’d now like to hand the presentation over to Darren Parmenter.

Darren Parmenter

Thank you, Jeremy. Our net interest margin expanded by 56 basis points to 5.18% in the second quarter of 2014. Our yield on earning assets of 5.44% was driven by gross loans as average balances increased and average yields rose by 34 basis points.

The cost of our interest bearing liabilities declined, driven by a decrease in the cost of interest bearing deposits to 27 basis points as the bank continues to run off higher cost deposit balances. The decline in the cost of interest bearing deposit is slightly offset by an increase in the balance of other borrowings driven by funding needs associated with the mortgage origination segment. The higher net interest margin in the second quarter as compared to prior year was due to improved funding mix and yield on earning assets driven significantly by the First National Bank transaction.

For the second quarter, the tax equivalent net interest margin for Hilltop was 140 basis points greater due to purchase accounting. Accretion of discount on loans of $25.9 million, amortization of premium on acquired securities of 1 million and amortization of premium on acquired time deposits of $2.5 million.

Non-interest income was $203.3 million in the second quarter, down 15% from a year ago. Non-interest income from the mortgage origination segment declined $42.2 million from the second quarter of 2013 to $123 million in the second quarter 2014, representing 61% of the total non-interest income.

Net insurance premiums earned increased 2.2 million from the second quarter 2013 to $40.8 million, representing 20% of the total non-interest income. Financial advisory fees and commissions decreased $3.7 million from the second quarter 2013 to $22.3 million, representing 11% of the non-interest income. Accretion for the FDIC indemnification asset of $500,000 in the second quarter was also included in non-interest income.

Our non-interest expense was $251.2 million in the second quarter 2014, down 3.5% from prior year. Compensation declined $8.3 million from the second quarter 2013 to a $124.4 million in the second quarter 2014, due largely to lower variable compensation at the mortgage origination segment, offset by additional compensation in the FNB transaction.

Loss in LAE declined to $35.3 million in the second quarter from $48.2 million in the second quarter 2002. Occupancy and equipment increased to $25.8 million in the second quarter from $20.2 million in the second quarter 2013, up primarily due to the FNB transaction. Amortization of identifiable intangibles from purchase accounting was $2.6 million in the second quarter of 2014.

Our loans held for sale grew $523.7 million from Q1 2014, primarily due to spring and summer seasonal volume. Our gross covered loans held for investment increased 1.9% from the first quarter. We continue to work through problem loans and covered OREO acquired from the First National Bank transaction with covered loans net of allowance and covered OREO down $79 million since the first quarter.

Gross loans held for investment to deposit ratio increased to 74.1% in the second quarter 2014, up from 68.4% in the first quarter and 67.2% in the fourth quarter 2013. Total deposits declined $507.9 million in the second quarter as run off of higher cost interest bearing deposits outpaced the growth in non-interest bearing deposits.

Short-term borrowings grew by $695.8 million in the second quarter of 2014, the result of higher funding requirements associated with increase of loans held for sale, a decrease in deposits and a slight increase in loans. Our common equity increased $41.9 million in earnings and improved AOCI.

With that I’d like to turn the call over to Alan White.

Alan White

Good morning and thank you. The bank a good second quarter. We continue to organically grow the legacy bank, while we try to continue to integrate and improve the former First National Bank that we purchased. We hired eight new lenders, seasoned lenders in second quarter to help grow our loan portfolio. A significant number of these are in new markets such as Corpus and Houston that we have entered in. We’ve also received approval for five new branches, one in Downtown Corpus, the other one in Victoria and other one in Alice that’s in our Coastal Bend region. We have one approved in Downtown Houston and then we have an office that’s been approved in Aledo which is just outside of Fort Worth.

Our loan pipeline continues to be solid. We have a $1.2 billion unfunded commitments. About a third of those will be draw time notes which are basically real-estate loans that have been approved that will draw up. The other two-thirds or C&I type loans that are revolvers that will be used by companies when the economy is strong and when they build inventories and make capital expenditures.

Our credit quality remains very good. Our non-covered NPAs to total consolidated assets reduced itself to 0.30%, which is very strong in quarter two and we think our loan portfolio is in really good shape. The acquired loans that we received in the First National Bank transaction are very high yielding. That’s helping us pay for the elevated expense that we had and trying to collect the loans that we acquired -- the covered loans that we acquired. That yield also helps us as we try to rationalize that platform of the First National into our platform as we make changes, ongoing.

PrimeLending continues to focus on the purchased business. It’s a challenging market. They continue to try to hire new producers. That becomes even more challenging as we go. They were very fortunate. They were able to improve their market share in the second quarter to 1.06, up from 0.84 and that’s on gross loans, all loans and it’s up from 0.66 days in quarter two of ‘13. So they are continuing to improve market share but that’s on a last base -- a significant amount according to Mortgage Bankers Association.

We’re still hanging in there at about 84% purchase versus 67% in quarter two in 2013. U.S. mortgage volume projected to decline 50% in quarter two. Our volume actually declined 20% over quarter two last year. So you can see we’re holding in there well, but it promises to continue to be a tough year in the mortgage business and to achieve the volumes that we’ve had in the past can be very difficult.

First Southwest continues to have pressure on them year-over-year annual year because of decline in the public finance markets. There are just not many projects and many refundings going on. We hope that changes in the future but we continue to sill do well in the clearing side of our business and the TBA side of our business. And First Southwest also provides about $300 million in core funding to us. So that is very beneficial to the bank.

And with that I’ll turn it over to John Martin to talk more about the financials in the bank. John.

John Martin

Thank you and good morning. The banking segment had income before tax of 41.5 million in the second quarter of ‘14. Net interest income grew 32.4% compared to the same quarter of last year. Our gross loans held for investment were flat compared to the first quarter of ’14, with the non-covered portfolio up about $68 million. Approximately 84% of our non-interest expense increased from the second quarter of 2013 to the second quarter of ’14 that was related to the FNB transaction.

PrimeLending funds originations drew a $1.5 billion warehouse loan from the bank of which $1.3 billion was drawn at June 30th. The bank continues to maintain excess capital with a tier 1 leverage ratio of 9.97% and a total risk based capital ratio of 13.9%. Total loans were $4.6 billion, total deposits $6.2 billion.

We look at our portfolio from various angles because we have covered a non-covered portfolio and within those portfolios we have PCI, Purchase Credit Impaired loans and non-purchase credit impaired loans. Our covered PCI loans had a carry value of $595.2 million. Our non-covered PCI loans, large loans acquired in the PlainsCapital transaction were $60.8 million. Our Non-covered PCI loans we carried at $250 million and the rest of the portfolio was carried at $3.7 billion.

Purchase credit impaired loans are loans we have with evidence of credit quality deterioration for which it's probable but not all the contractually required payments will be collected. Our PCI loans include covered and non-covered loans. PCI loans have a total discount of $302 million at June 30, 2013. $279 million of this discount was related to the covered portfolio. Increases in expected cash flows in the second quarter of 2014, up $26.9 million for covered PCI loans and $6.1 million for non-covered PCI loans. The weighted average expected loss on our PCI portfolio associated with the PlainsCapital merger was 23% and related to the FNB transaction was 24%.

Our non-PCI loans include newly originated loans acquired loans without credit impairment at acquisition and it acquired non-PCI loans that have been renewed. Non-PCI loans include covered and non-covered loans. The portfolio had a balance at 98% of unpaid principal balance with a total discount of $47.5 million. $30.1 million of that discount was related to non-covered loans while covered loans had a discount of $17.3 million.

Income before taxes in our mortgage origination segment was $9.2 million, a decline year-over-year due to lower origination volume offset by decline in variable compensation expense. Origination volume in the second quarter was $2.8 million, purchase volume was up 1%, refinance volume declined 33% and total volume to 16% of total volume in the same period.

Net gains from interest rate lock commitments totaled $25.7 million and $6.9 million during the second quarter of 2014 and second quarter of 2013 respectively. Salaries and benefits and segment operating cost for the second quarter of 2014 decreased approximately 11%, compared to the same period last year as benefits in headcount reduction that occurred in the third and fourth quarters of 2013 were realized.

The MSR was valued at $35.9 million on a $3.3 billion service portfolio at June 30 compared to $29.9 or $2.7 billion at the end of March 2014. In July we sold MSR assets of about $11.4 million which represented approximately $1 billion of the segment service loan portfolio.

First Southwest had a pretax income of $640,000 in the second quarter versus $2 million in pretax income and that’s same period of last year. Non-interest income declined $3 million, partially offset by non-interest expense decline to $2 million.

Non-interest expenses were down year-over-year, mainly driven by decreases in compensation with revenue. Substantial amount of non-interest income was driven by public finance, capital markets and clearing. The TBA business, which provides interest rate protection for housing authorities had a fair value changes on derivatives that provide gains of $3.2 million in the quarter.

With that, I will turn it back to Darren to discuss National Lloyds Corporation.

Darren Parmenter

Thank you, John. Consistent with our historic results, we expect higher losses in the second quarter from seasonal hail, wind and tornado events in Texas. Growth in earned premium and improved claims loss experience drove a $15 million year-over-year improvement in pre-tax loss. Based on our estimates of ultimate losses, claims associated with the 2014 storms totaled $14.3 million as compared to $20.9 million at the same point a year ago.

In 2013, we initiated rate filings, performed a review of the business concentration which resulted in cancellation of agents, non-renewal policies and ceasing new business writings on certain products and problematic geographic areas. This has reduced the rate of premium growth in the first six months of 2014 and we expect a reduction in exposure to volatile weather going forward.

With that, I’d like to turn it over to Isabell Novakov.

Isabell Novakov

This concludes our prepared remarks. We will now take questions.

Question-and-Answer Session

Operator

We will now begin question-and-answer session. (Operator Instructions). Our first question is from Brady Gailey from KBW. Please go ahead sir. Our next question is from Michael Rose from Raymond James. Please go ahead.

Michael Rose - Raymond James

Couple of questions for you and I know you’re probably not going to comment on the SWS deal too much. But I did notice some law suits in the queue. Just wanted to get sense for if the deal is pushed back, can you remind us if there is a provision to extend the deadline for the transaction. And then on a related note, assuming the deal closed at the end of the year, this will pushover the $10 billion threshold. We’ve seen a lot of banks that are $10 billion be subject to additional BSA/AML type of cost. Is this built into your model and maybe what could we expect there?

Jeremy Ford

This is Jeremy Ford. On the SWS transaction I think as part as the law suits, they weren’t necessarily unexpected by us and we’re going through the process on that. I think the fact that we had a large ownership position in it beforehand just inside those. As far as the timing on it, we still feel like we’re going to close by yearend and hopefully sometime within the fourth quarter. And we have till -- March 31st is the deadline of next year and if we want to mutually agree to extend that deadline we could do that as well. Right now we’re focused on the shareholder growth for SWS, which we expect in the early part of the fourth quarter. So is that good on SWS?

Michael Rose - Raymond James

Yes that’s helpful. And then if I can just move to the core margin, up about 11 basis points quarter-to-quarter. I understand there is some positive earning asset mix shift. How should we think about the core margin as we move forward? Obviously we understand the reported margin is going to be noisy with the accretion.

Jeremy Ford

The core margin, we expect it to hold in that range while rates are in the level that they are in now. So we would expect it to be around that 350 mark.

Michael Rose - Raymond James

And then just finally, I know you guys have opened up some new offices and hired some new people in some other geographies. Just wanted to get a sense for how much of the growth this quarter in the non-PCI portfolio, the core growth was from some of those newer territories or lenders that you hired?

Jeremy Ford

Well if you looked the way we look at our loans, and we look at it from an organic standpoint, from a legacy bank and that types the held for sale and that types of margin loans, excluding our warehouse and excluding those covered transaction, we’re running about 11% on an annualized growth rate. So we think we can continue along that way. We think these people will bring additional strength to this. Obviously they haven’t been with us that long to really effect what we’re talking about there, but we -- it will help us hold in there and get our share of what’s out there. So our annual growth rates running in the legacy bank about 11%. You got to realize in the covered side we’re trying to get loans paid off, we’re trying to collect those loans. So those loans are going down. So it’s really hard to look at it when you fill everything in there. You’ve got to kind of separate it out to really get a feel for where we’re going on the loan growth.

Operator

And our next question is from Brett Rabatin from Sterne, Agee. Please go ahead sir.

Brett Rabatin - Sterne, Agee

I wanted to first I guess ask that expense question again. I didn’t hear an answer around that and everyone is sort of worried about increased regulatory oversight cost. So was just curious where you guys stand on that and if you expect to spend any money on back office for BSA/AML kind of stuff, especially over $10 billion.

Jeremy Ford

Prior to the transaction we had embarked on a project to enhance our enterprise risk management system. We’re in the process of doing that and feel very comfortable that when we cross the $10 billion mark that we will have the risk management in place to handle. It is going to be expensive. However on the anti-money laundering and BSA area, I think that our systems prior to the transaction were pretty robust and that while we’ll continue to improve them that we’re not starting from scratch there.

Brett Rabatin - Sterne, Agee

And then secondly, when you guys talk about the legacy bank with 11% growth rate, is that net or are you sort of including the payoff activity in your portfolio? I know that’s been a bit of an issue for the past quarters.

Jeremy Ford

We’re including it. That's net.

Brett Rabatin - Sterne, Agee

And then I guess the other thing I wanted to go through was in the Q you included your asset sensitivity, which you guys continue to model yourself slightly actually liability sensitive in an uprate environment. Are you guys going to do anything? I know you’ve obviously changed the deposits this quarter quite a bit. Are you guys looking to do anything to make yourself at least neutral interest rates to possibly going to be asset sensitive?

John Martin

We’re examining a number of things. That the transaction that we entered into last September had a pretty dramatic effect on that position and we continue to evaluate how we will manage those assets in order to get us back to more of a neutral position.

Brett Rabatin - Sterne, Agee

Should we expect to see you guys neutral in interest rates in the 10-Q over the next few quarters or how should we think about that?

John Martin

I would say it would be over a little longer horizon than that but certainly within a year or so.

Operator

And our next question comes from Matt Olney from Stephens. Please go ahead.

Matt Olney - Stephens

Hey, wanted to ask about PrimeLending, the mortgage business. It looks pretty good profitability in 2Q but there were some tailwinds I think from some of those interest rate lock commitments. I'm trying to understand the overall profitability of that segment kind of in this new mortgage environment? And how important is selling the MSRs from time to time to the overall profitability of the mortgage company?

John Martin

So I wouldn’t describe selling those is something key to the overall profitability of the segment. I think that’s more managing our balance sheet risk and making sure that we're comfortable with the level on there. So I wouldn’t describe that as a key component of the profitability.

Alan White

Matt as far as the question about profitability and where is the mortgage industry, we saw a tough first quarter because of weather and normally traditional mortgage market in the first quarter is tough. We saw a comeback in the second quarter, certainly not to the levels that we’ve been used to but it came back and it drove a good bottom line for us, again not what we were used to. It was up significantly from the year prior and I think as we go forward, we're not going to see the volumes that we’ve seen. Even though we’re getting bigger market share, the base out there is strong. And so I think we’re back into where it used to be. Now whatever it used to be means I don’t know because you have to look back several years before refinance started going crazy. So we look forward to be a different than what it was, not what it was but by no means -- we are as not profitable or we are not doing okay in it.

Matt Olney - Stephens

So Alan, any updated commentary on overall gain on sale margins in the business?

Alan White

They are down a little bit. There is a squeeze out there. There is lots of competition for what’s out there. So the margins are -- the squeeze is there you're seeing companies fall out but you are starting to see that become less and less and the ones that are going to survive are going to survive and we just need the market to pick up. We hope a 4% GDP would get homebuilders out there building houses and get people confident in buying them. So you’ve got to look to the positive but in the meantime, if we continue to gain market share, we’re going to be able to hold in there and that’s what our goal is. We want to get through this time that we're in and be in a position when it does around, because we are such a strong purchase company that we can take advantage of the upside.

Matt Olney - Stephens

And Alan, would you expect to add additional producers in that business?

Alan White

We are trying to, and it has become a little bit more tougher now that there is fewer and fewer going down the two. It’s harder to get those people away. We were pretty flat in the second quarter as far as a number of mortgage bankers. So it’s getting tougher, you're starting to see some consolidation in that industry, some M&A in that industry. So we will continue to work hard at it and continue to try to hire people and hire teams. It's just a little more difficult right now.

Matt Olney - Stephens

Okay. And then shifting over towards the Bank. Alan I guess some of your peers in Texas have made some interesting comments already this week as far as increasing line utilizations from some other commercial borrowers compared to this year. Are you seeing any of that in terms of utilization rates?

Alan White

Not a whole lot. It’s still, on our unfunded commitments we're not seeing a lot of people taking money down and doing things with it. Where we're seeing the most activity is on the real estate side in the projects that we’ve committed to, those things are trending up. But we are seeing quite a bit of the activity; people out there lining up to borrow money. And our pipeline is pretty strong. This takes a little while to get these things done. You just can’t get them done as quicker as it used to be able to because of all the regulatory issues it involves. But we're seeing a pretty good pipeline and there's couple of these new markets for us that are doing well and there's are a couple of other markets. Austin is a strong market for us right now. So we’re seeing a lot of activity. Some of them are just huge loans but the $5 million to $10 million deals are right down the fairway and we lack those. So we’re seeing a lot of business. It’s just taking a little longer to close it and of course you know, its summer time and you got to get everybody back to work. But I think business is okay. I’d like to see those people draw down on those lines of credit they have.

Matt Olney - Stephens

And then in the insurance business and we’ve talked before about you de-risking that portfolio over the last year or so. 2Q this year still a loss but much less so than last year. Was the overall performance in 2Q kind of within your expectations given Q2 can be challenging pretty seasonally? And secondly the overall profitability of that business. Now that you've de-risked that, how should we be thinking about the overall profitability of the insurance business?

Jeremy Ford

The second quarter was within our expectations of losses. We just have the seasonal weather in Texas. So we’re pleased actually with the quarter. And I think you look at the second half for the year like it performed the second half of last year. And so we expect it to be profitable and to have a decent year.

Operator

And our next question is from Frank Barlow from KBW. Please go ahead sir.

Brady Gailey - KBW

It’s actually Brady Gailey. So on the deposit shrinkage, can you just comment, in is that coming from the FNB deposits that are running off? And when do you expect deposit balances to somewhat stabilize?

John Martin

Brady, this is John Martin. It comes from both the FNB side and from the legacy side, and largely from the FNB side where we had some listing service deposits when we took over, as well as some high cost CDs. But we’ve also reduced some of our higher cost deposits at the legacy bank.

Second quarter is also a seasonal drop force. We usually have a small drop in our deposit balances. So I think we’re seeing -- we still have some listing service deposits, I think about little over $100 million that we’re not going to encourage to stick around. But I think we’re seeing the end of our deposit shrinkage.

Brady Gailey - KBW

Okay. Even after SWS closes, you’ll still have excess capital. Is it safe to say you’re not necessarily focused on Texas Bank M&A is up today but maybe after SWS happens as we get to 2015 you’ll be a lot more focused on building out the Texas Bank via M&A?

John Martin

I think it’s safe to say our primary focus is the closed SWS transaction and after that we’ll be Texas M&A, bank M&A to fill that out.

Brady Gailey - KBW

And then lastly, looking at loan growth, you have the legacy bank. It looks like over the last couple of quarters it’s kind of been slowing. Is there anything to read into that or is that just quarter-to-quarter volatility?

Jeremy Ford

Really the legacy bank, it’s really been hanging about 11% on an annualized basis, because what you can’t, you got to watch as the other bad bank so to speak and we’re trying to pay that down. And that's kind of convoluted but the legacy banks loan growth has been just fine and it continues to be just fine. And I would continue -- I would think that we continue on that 10% to 11% annualized growth rate for the balance of the year. On the same token we would consider the covered transaction portfolio hopefully continue to go our [ph] markets going down. That’s exactly what we’re trying to do.

Operator

And ladies and gentlemen, this will conclude our question-and-answer session as well as today’s call. We thank you for attending today’s presentation. You may now disconnect your lines.

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